A Look At Chesapeake’s NGL Production Guidance

Chesapeake Energy’s (NYSE:CHK) guidance for 2014 was seen as relatively lackluster, with overall production poised to grow by just 2% to 4% year-over-year. However, the company’s natural gas liquids (NGL) targets proved to be a bright spot, with volumes slated to rise by as much as 45% year-over-year. In this note, we take a look at the NGL business and some of the reasons behind the increase in Chesapeake’s NGL production outlook.

See our complete analysis for Chesapeake Energy here

We have a $26 price estimate for Chesapeake Energy, which is slightly above the current market price.

Natural Gas Liquids Have Better Price Realizations Compared To Gas

Low gas prices over the last few years have led oil and gas companies to focus on liquids rich plays. NGLs are more profitable when compared to natural gas on an energy equivalent basis and their prices are also relatively less volatile. NGLs contain a mix of hydrocarbons such as ethane, propane, butane, isobutene and pentane, which have different applications and fetch different prices in the market. Ethane is typically the largest component of NGLs (roughly 40%, could vary by producer) followed by propane. ((Why natural gas liquids prices continued to slip last week, Market Realist, February 2014)) Ethane is used to produce ethylene, an important raw material in the plastic and detergent industries, while propane is used for heating  and as a feedstock in the petrochemicals industry. NGL production requires a lot of infrastructure for processing, fractionation and transportation. Processing facilities extract the liquids from the hydrocarbons and separate it from gas. After this, the liquids are split into various NGL components through a process called fractionation.

While NGL prices have typically moved in tandem with crude oil prices, recently there has been some disparity since the supply of ethane and propane has increased due to the shale boom, sending prices lower. Ethane prices are under $0.50 per gallon, while propane and other components such as propane and butane sell for over $1.35 per gallon. While Chesapeake does not disclose the composition of its NGL, the company realized an average price of around $28 per barrel of NGL in 2013. ^[1]

Infrastructure Improvements In The Utica Shale and Higher Ethane Recovery Are Drivers

Chesapeake’s NGL production has seen significant growth over the last few years, rising from around 15 million barrels (mmbl) in 2011 to around 21 mmbl in 2013. For this year, the company expects volumes to rise by between 40% to 45%. The company’s operations in the liquids-rich Utica shale are likely to be a crucial contributor to this growth, as some of the infrastructure related issues in the region have been easing. While transportation capacity is set to rise as new pipelines such as the Appalachia-to-Texas Express (which connects the region to the Texas Gulf Coast) begin operations, additional processing facilities have also begun operations.  ((Chesapeake’s Big Opportunity in the Utica Shale, Motley Fool, February 2014))

Additionally, the company’s NGL production could also be aided by higher ethane recovery from its natural gas production. Low ethane prices made natural gas companies recover less ethane from the natural gas they shipped onto pipelines, resulting in a richer and higher value (since ethane has a higher energy content) gas. However, this year, Chesapeake has indicated that it would be recovering a greater percentage of ethane from its gas stream, which could lead to lower gas prices while boosting natural gas liquids production. ^[2]

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1. Chesapeake Energy FY2013 Form 10-K [↩]
2. Key drivers affecting the gas prices Chesapeake Energy receives, Market Realist, February 2014 [↩]